Comparing public, privately-held companies difficult
In a trial, Appraiser A testified as to the value of a convenience food store whose revenue came from the sale of food, gasoline, and the commissions from 16 rented slot machines operated by a slot company. His valuation was based on transaction data derived from the private, closely held marketplace. Appraiser B valued the same business using the public market; data obtained from Harrah’s and Caesar’s hotel-casinos. The judge was livid as he told Appraiser B to step off the witness stand. He said that Appraiser B insulted the intelligence of the court by attempting to compare public companies with a small mom-and-pop business. It was similar to comparing a $175,000 home in a small community with a $17 million home on Lake Tahoe.
Some of the major differences between public companies and private, closely held businesses.
Public companies are composed of thousands of minority shareholders who have no “say so” in the operation or management of the business. Shares are easily sold in the public market, often just based on a phone call to “sell.” Public companies are run by their boards of directors and a commander in chief, usually called a c executive officer) or chief operating officer. Public companies are typically in more than one business. For example, Disney Corporation also owns American Broadcasting Company General Electric and Westinghouse are in numerous businesses including the broadcasting business. Public companies must provide audited financial statements.
Public companies have multi-layers of management and can, and do, hire experts in many fields. Financing is available for public companies that is not available for private, closely held businesses. The risk in publicly traded shares is less than for private, closely held businesses, therefore the returns are less. The holding periods for publicly traded stock may be minutes, hours or days. Information regarding the performance of a public company is readily available through numerous sources.
Private, closely held companies are a “horse of a different breed.” Ownership may consist of a single owner (the decision maker), or of several owners. Ownership typically operates and manages the business and family members are often employed. Management depth is typically thin.
The business is not easily sold and often times it can take years to sell. Minority interests are even more difficult to sell and are usually subject to discounts for lack of control and marketability. Private companies are typically in one business only and the majority owner is typically the expert. It is a rarity when a smaller business can afford to pay outside experts. Financing is difficult for private companies and is often limited to the borrowing power of the owner. It is common practice for these types of businesses to be passed down through inheritance and kept within a family. Risk is great in a private company, so the required returns must therefore be greater. Private, closely held companies rarely produce audited financial statements. Information regarding the performance of a private, closely held company is of a highly confidential nature and is not readily available.
Statistical data relative to private, closely held companies is compiled by classification codes that were established by the Federal Office of Budget and Management many years ago. There are over 5,000 types of businesses contained in the codes. For example, under “Retail Apparel,” there are approximately 50 different types of apparel businesses (hats, shoes, women’s wear, men’s wear, children’s wear, sportswear, etc.). In recent years the SIC codes that originally were developed have been replaced by NAICS (North American Industrial Classification System) that provides data on businesses that did not exist when SIC was first established (cell phones, iPads, computers, etc.).
When comparing businesses, the appraiser must consider how these businesses market their merchandise or services, who their clients or customers are, where are they, how they are reached and how they operate compared to one another.
Data is collected from business brokers, accountants, banks and etc. The data includes date of sale; state where the transaction took place; gross revenue of the business; selling price; discretionary earnings; ratio of selling price to gross revenue and to discretionary earnings.
Gross revenue means “sales.”
Discretionary earnings are defined as “whatever the owner pockets in terms of money, perquisites, benefits, write offs, and whatever has monetary value that adheres to an owner.” Examples include excessive rent if business owner and landlord are the same, depreciation (a non-cash, tax related write off), personal insurances, owner’s compensation if it’s either excessive or insufficient and compensation to family members who don’t actually work even thought they are on the payroll.
The largest data bank is that of the Institute of Business Appraisers consists of approximately 35,000 transactions all across the United States. The next largest consists of approximately 10,000-12,000 completed transactions. Industry data is also derived from private data sources.
Jerry F. Golanty is president of BizVal, a Reno based valuation and consulting firm. Contact him at email@example.com.
Per the agreement, Caesars will continue to operate Harrah’s for the first half of 2020 before it’s redeveloped into a non-gaming hotel and mixed-use development.